Banning Interest

26 January 2013

Author: Bart klein Ikink

Introduction

On January 22, 2012, Jonathan Goodwin posted an article on Mises.org about the Wörgl stamp scrip in which he explained that the success of the currency was largely caused by the payment of taxes in arrears, and that the success of the Wörgl currency would have been short lived if it had not banned by the government because the currency was not legal tender.

He also wrote that all scrip would be exchanged for Schillings, but in my opinion this depends on the possibilities to spend the scrip locally. Assuming that the scrip was fully backed by Schillings, and there was little risk of ending the backing, the scrip that could be spent locally would remain in circulation, while the remainder would be exchanged for Schillings.

I wrote Jonathan Goodwin an e-mail about his article and an exchange of e-mails followed. He wanted to write on his blog about the e-mail exchange, and I wrote him that it was a good idea to have an exchange of viewpoints.

This is my reply on the questions asked in this blog post in the Bionic Mosquito blog. I have tried to answer all the questions and grouped the answers into a few paragraphs.

Will it be implemented by force?

Whether or not something is implemented by force is the central theme of libertarian thinking. If it is implemented by force then libertarians think that it must be wrong. There are two domains: the public and the private. In my opinion, the public domain should be ruled by democratic decision making. I am strongly in favour of referendums like in Switzerland so the government can be completely controlled by the citizens. Referendums should be implemented on all levels: municipality, state/province and country.

Assuming that a country decides after a referendum to implement a specific type of money, make it legal tender and ban other types of money, is this force? Market participants have the option to buy gold or foreign currencies, so if it is a bad plan then markets will end it. If the market ends the plan, is this force? You can argue that markets force people to do things they do not want to do. We live in reality as it is and we have to accept that.

The statement that "centrally planned solutions can never be justified – neither for the means nor the ends" is a political view. There are traffic rules for instance, and other rules everyone thinks are justified, and they are enforced by a central government. The same may or may not apply on the type of money used within the borders of a country. The point here is: Are people free to democratically decide on the issue of money?

I think people should be free to make democratic choices on money, and choose the ways to enforce the rules they make. But bad decisions do have consequences, for example capital flight. If the interest free economy is more efficient then a successful experiment will be copied and the interest free economy will attract capital at the expense of the interest based economy. In this situation more people will choose Natural Money of their free will or economic conditions will enforce Natural Money. If it is a bad idea then it will be discarded.

A reader asked: Who will be receiving the tax on the money? Most likely this will be the government issuing the currency. The holding tax can be used to reduce other taxes or to increase government spending depending on the democratic choices made by the people.

What is the right way?

I made a theoretical discovery, which is that under specific conditions free money, which is money with a holding fee, combined with a ban on interest and a ban on creating money by governments and banks, will create a more efficient economy. I think it will be more efficient than (1) Keynessian deficit spending and (2) Austrian boom/bust cycle economics.

The theory of Natural Money is related to the theories of Silvio Gesell and Bernard Lietaer, but there are essential differences. Gesell and Lietaer do not propose a ban on charging interest like I do, nor do they explicitly state that money supply should be fixed (e.g. constant). They also do not explain how banks can operate in a system without interest. I am alone on those issues, and consequently I have chosen to explore the consequences of those ideas myself.

At first it seemed that the Wörgl experiment confirmed the theory of Natural Money, but over the years I realised that this is not completely true because similar experiments did not yield similar results. You have explained in your article that the extra tax income in Wörgl was not sustainable. I think this is partly true. Only if taxes have been paid that otherwise would not have been paid, this would have been a real benefit that was sustainable.

Still, the theoretical discovery that a more efficient economy with Natural Money is possible has not been refuted, nor is it proven. There is an example of free money in operation for 1,500 years. Joseph introduced grain storage in Egypt around 1,500 BC. He also caused the introduction of free money by his actions. This system lasted until the Romans forced gold and silver as money upon the Egyptians. So, the idea that free money is not sustainable in the long term is contradicted by facts, see:

There apparently was no force needed to make people accept the money. So free money is natural and not contradicting human behaviour like you assert. The scheme could not have lasted for 1,500 years and survive periods of trouble and changes in governments, if it was unnatural. I think free money is more efficient so I am looking for the right way to implement it. If anyone comes up with ideas of value, I greatly appreciate that. If people find errors in the theories, I think this can improve the the theories.

There are three types of criticism: (1) valid criticism pointing at errors and issues that have been overlooked, (2) criticism based on lack of understanding of the concept and (3) politically motivated criticism that does not touch the issue of superior efficiency but is merely an issue of preferences. I have had many discussions and I have become convinced that the basic idea is sound and that criticism can improve the theories. This is the reason why I engage in discussions on sites with people that have other views.

The borrower is servant to the lender

The borrower/lender relationship has been an age old issue. Money is not neutral. You can view money as: (1) a unit of accounting, (2) a possession, (3) a service provided by the government. These views are political, so depending on your political position you may prefer a specific view. Interest causes many problems. Some of those problems are political issues and not everyone agrees on them, but some others are indisputable after closer study. Disputes are often caused by a lack of understanding of the consequences of interest. Some of the problems caused by interest are mentioned here:

Why does The Bible condemn charging interest? The lender/borrower relationship with interest is oppressive in nature. He or she who owns money is in command, at least when the money is gold or silver. The rich had the choice to give the poor a job or to lend them money. The poor had no choice and if they were lucky then a job was offered. It was bad luck when they had to borrow money at interest. When the rich did not spend their money, the interest could never be repaid. You write that the lender suffers there, but it was his or her own choice to make it impossible for the borrower to repay by not spending the money and hiring poor people.

Historically interest rates have been between 20 and 40 percent annually and interest caused debt slavery. It is less clear today because the economy has become dependent on the expansion of debt. Savers are punished and interest rates for savers are below money supply growth. Still, borrowers with credit cards pay interest rates between 15 and 30 percent annually. A libertarian will argue that people who borrow at those rates were free to choose to buy a new car or a flat screen TV, and that they were stupid to borrow for unnecessary items. I agree with that. They have become debt slaves because they bought items they cannot afford and do not need. But they have become debt slaves nonetheless.

For those reasons I argue that there is no economic freedom with interest. Poor people may be poor because they are stupid or incompetent, but this is not always true, and the economic system should not exploit poor people. The more they are protected from their own stupidity or their bad luck, the better it is for the general well being. Libertarians do not like this point of view and most likely they will differ with me on this issue. It should be noted that a society of free people will be more prosperous, and this is one of the reasons why Natural Money may be more efficient, as the example of Solon points out.

Around 500 BC agricultural output in Greece was not able to keep up with increasing population. Because of interest charges, mostly paid to city people, the debt load for farmers had gotten out of hand so that many of them could no longer pay their debts and were forced into slavery. Farms became the property of rich city people who did not understand farm work, while slavery did not contribute to the productivity of agriculture. Harvests declined and the people in the cities were threatened by famine. Solon realised that a healthy countryside is a countryside without debts:

Economic downturns

You assume that economic downturns are brought on by the cleansing of the bad investments brought on by the prior expansionary money and credit schemes made possible by central banks. Economic cycles are not primarily caused by central banking. Bad investments are primarily caused by optimism, and can be fuelled by cheap credit, and central banks can make credit cheaper. There have been economic cycles before central banks were installed and partly they were caused by fractional reserve banking.

Since banks lend out most of the cash they receive in deposits, it is difficult for them to quickly pay back all deposits if these are suddenly demanded, so a run renders the bank insolvent, causing customers to lose their deposits. A financial crisis often precedes an economic crises, for example in 1929 and 2008. The goldsmiths invented fractional reserve banking in the 13th century. Central banks were introduced to solve the problems caused by fractional reserve banking, but interfering with markets in this way only aggravates the problem.

In my view economic cycles are primarily caused by the buildup of debt. Periodically the interest charged on debts causes a reduction in demand as debtors have less free income to spend because they have to pay interest. This causes an economic downturn and debtors will have even less free income to spend, which reinforces the downturn. Banning interest will create more free income for debtors but it will also cause a reduction in debt levels as there is no allowance for excessive risk in the form of interest on money:

You suggest that I argue for cheaper credit. Natural Money includes a limit on credit as banks cannot create money. All loans must be made out of savings. An essential feature of Natural Money is the ban on interest, which creates a maximum risk allowance. There is a holding tax on money so there is an incentive to lend at 0% because the holding tax can be avoided in this way. But banks will choose the best borrowers because (1) credit is limited and (2) there is no reward for excessive risk taking in the form of interest. This prevents economic booms from emerging and consequently busts. It is likely that the economy will remain stable and grow constantly with Natural Money.

Interest is an allowance for risk and 'no cost money'

You write that interest is an allowance for risk because there already is risk. The risk exists before the interest, not because of it. You think that I have it backwards. The meaning of my statement is that interest allows risk to be introduced in the financial system. Consequently, the public suffers from the risks private individuals take. I think that it should be better when private individuals take the risks themselves by bringing in more equity.

Somehow you seem to have problems with my statement that, with Natural Money, debts cannot grow out of control because of interest charges. 'I am suggesting no cost money,' you write. How much does it cost to create a fiat currency unit? It can be created at no cost. I do not talk about gold and silver here. I do not think that people will lend out gold and silver at 0%. However, it is possible to lend money at 0% if there is a holding fee on the money. I think your assumptions are based on gold and silver as money (or interest bearing fiat money) and this is where your reasoning goes wrong.

You ask why must risky projects be financed with equity and what if management and shareholders believe it is preferable to finance such a project with debt? What if a bank is willing to lend? If there is a ban on interest then there is a maximum risk allowance, which is the reward for avoiding the holding tax. There is no reason to enforce this as it is a consequence of banning interest. I do not intend to outlaw loss either. But with Natural Money, banks will only finance projects if the risks are limited.

You assert that there is nothing about my theory that will disallow someone from borrowing more than he or she can repay. That is not true. The ban on interest will curb risk taking. A lender will check the borrower better and if he or she is not trustworthy or incapable of repaying then the lender will not lend the money. Of course the borrower can get into trouble but the lender will require that the borrower brings in equity, for example if the borrower wants a mortgage to buy a house. The borrower still has to make monthly payments and these payments will reduce the principal. You can never be sure about the long term prospects of a borrower, but it is clear that banning interest will reduce risk taking. The absence of economic cycles will reduce risks even further as the income of the borrower will be more predictable.

A more specific definition of Capitalism

Within the context of Natural Money Capitalism is defined as private enterprise within an interest based economy. I think that interest on money and not private enterprise is causing problems. Less government and regulation is feasible when there is a ban on interest. This is because interest is the root cause of many problems governments are trying to solve with their interventions. I think that economic unfreedom and government intervention are primarily caused by interest on money.

The expansion of government and the welfare state are consequences of failures in Capitalism caused by interest on money. With interest the poor will become the majority. They will elect people that try to stop economic laws from functioning because those laws are considered to be unjust. Many poor will then become dependent on the state. In this way civilisation collapses because of interest on money. If you take away the root cause then you need less government intervention. Another issue is government intervention to protect the environment. I have explained the relationship between interest and unsustainable economic development:

On this example, you have criticism. You ask me: "Is tripling the life of the house the best choice one might have for his incremental 200,000 units?" If the alternative is destroying the planet and killing my children then I am inclined to think so. If the decision to make short term investments is caused by interest, and there is no real economic ground behind the decision, then I am inclined to think so. I do think that interest distorts markets because it alters the cost picture.

Assuming that economic growth as we have now is not sustainable, and that it will lead to a mass die-off of humanity, there is no freedom to choose for a survival of humanity within the current economic system. The example demonstrates that interest favours short term thinking. We need to change the system to survive. Only a ban on interest will make it feasible to build a sustainable economy to avert a mass die-off of humanity.

A complete free market in money

I do not oppose a free market in money, but only if people choose so democratically, for example in a referendum. If people make democratic choices to make certain types of money legal tender, and outlaw other types of money, then I will accept that. If it is a democratic choice to punish people for using gold and silver as payment, then I will accept that. But bad decisions do have consequences. If the currency is not attractive, then it can cause a capital flight.

My theory is that Natural Money will be superior in efficiency and will make other types of money obsolete. In free competition Natural Money, which is money with a holding fee combined with a ban on interest and a ban on creating money by governments and banks, will become the dominant type of money once it is applied somewhere in the right way. But this is a theory that has not been proven in reality.

Of course I am looking for people who want to cooperate with me and work on the idea. Until now that has not happened. I do not have the resources to make myself noticed. I do not need people who tell me how great my ideas are and do nothing to help me. This already happened a few times. People who criticise me are more useful as they help me to improve the theories. I have decided that it is not my problem that nobody is on my side because the project has much in common with a Mission Impossible. I can only do my best.

Therefore I work on my theories alone, engage in discussions, and rethink the theories. If the theories are valuable, then they may be noticed one day, and people may see that I am on to something. Until now that has not happened, but nobody has been able to convince me that I am wrong about the basic assumptions in the theories of Natural Money. I hope that one day the theories will be tested. But I have to be realistic. It seems unlikely that it will happen in the near future.